There’s a lengthy body of evidence demonstrating that trying to time equity or bond markets is a loser’s game. As one of our leading institutions of higher learning, you would think Harvard University would listen to the academic evidence. It didn’t, and its gamble will cost its endowment nearly $1 billion.
Harvard made a bet through interest-rate swaps that interest rates would rise. When that bet failed, the school paid $497.6 million to get out of $1.1 billion of interest-rate swaps. It also agreed to pay $425 million over 30 to 40 years to offset an additional $764 million in swaps.
Harvard should have known better than to try to time the market, given the academic evidence. There’s no academic evidence of the persistent ability to outperform risk-adjusted benchmarks, beyond the randomly expected.
For example, John Bogle of Vanguard studied the performance of bond funds. In his book Bogle on Mutual Funds, he concluded: “Although past absolute returns of bond funds are a flawed predictor of future returns, there is a fairly easy way to predict future relative returns.” Bogle found “superior funds could have been systemically identified based solely on their lower expense ratios.” Other studies on the subject reach the same conclusions:
- Past performance can’t be used to predict future performance.
- On average, actively managed funds don’t provide value added in terms of returns.
- The major cause of underperformance is expenses. There’s a consistent one-for-one negative relationship between expense ratios and net returns.
Michael Evans, founder of Chase Econometrics (now IHS Global Insight), confessed: “The problem with macro [economic] forecasting is that no one can do it.” Since the underlying basis of interest-rate forecasts is an economic forecast, the evidence suggests that bond market strategists who predict bull and bear markets will have no greater success than do the economists.
Harvard not only went against the evidence, but it also violated one of the more basic principles of risk management — long-term (capital) projects should be financed with long-term debt. Investors shouldn’t make speculative bets on rates either. A prudent strategy is to build a laddered portfolio to diversify the risks of reinvestment and inflation.
